Check21 Remittances

Contrary to popular belief, remittances (money-transfer) entail more than just a person walking into a retail location to send money overseas, there also exists other business areas that few people outside the check cashing world know of.

However, before we discus of the opportunity, it is important to under stand two important areas:

• Check21
• FATCA

Briefly understanding both of these is crucial to the problem I will discuss below and the opportunity it represents.

Check21

Check21 is a US federal mandate that allows check truncation, and allows a digital image of the check to be processed. This law was mandated in the US after September 11 (2001) at which time, the US air traffic was halted and as a result, all checks that were physically transported for processing, stopped because no planes were flying.

To further strengthen the US financial system, it was deemed necessary to introduce check truncation so that digital images could be processed by the Federal Reserve and not have to rely on physical checks.

The Check Clearing for the 21st Century Act (or Check 21 Act) is a United States federal law, Pub.L. 108–100, that was enacted on October 28, 2003 by the 108th U.S. Congress. The Check 21 Act took effect one year later on October 28, 2004. The law allows the recipient of the original paper check to create a digital version of the original check, a process known as check truncation, into an electronic format called a “substitute check”, thereby eliminating the need for further handling of the physical document.

Source: Wikipedia

FATCA

Another area to briefly understand is FATCA, which stands for Foreign Account Tax Compliance Act* as issued by the Internal Revenue Services (IRS) on behalf of the US Government

*Not to be confused with Fair and Accurate Credit Transactions Act part of the Fair Credit Reporting Act.

FATCA basically says if you are a US Citizen and have an offshore bank account, you need to report this to the IRS. It also places burden on the foreign Banks and other Financial Institutions outside the US to ensure that if US citizens open a bank account with them, that the Bank reports the same to the US authorities.

More information on FATCA can be found here on IRS’s website.

Long story short, if you are an American Citizen, and you go to a bank (outside the US) to open a bank account, you have to declare this to the IRS and so does the bank. So what does the bank do? They decide not to take your business so that they don’t have to get into any registration and reporting with the US authorities.

Think this is a singular issue? It is not. Today, for an American to open a bank account abroad, is nearing to be an impossible task. Foreign bank’s don’t want to do business with American citizens. There is too much reporting and risk associated with this.

The Scenario: Check21 Payments

So where exactly is the problem and opportunity? I will discuss two scenarios here briefly, before you get an understanding of the problem.

Scenario A

Imagine you are a US parent of a child (who also is a US citizen), who has just been admitted to a university in Santiago in Chile.

You accompany your kid to Santiago to get him settled. When you go to a local bank to open a bank account, they refuse your business because…

• You’re a US Citizen
• FATCA Reporting

You try your luck at another banks. Same result. Try another bank. Same result. Pretty soon you realize, they’ve told you just plain f**k off. The banks don’t want your business.

Desperate to find some form of funding your kid, you find a money exchange and ask if they will cash a US check? And they say yes, they will, but it will take 1-2 weeks to get it done. No problem. You’re all set.

You now hand over a dozen or so checks to your son, and ask him to come to this money exchange company and cash them when he needs money.

Important to note: these are US drawn checks, on a US banks, issued in the US, and are simply being cashed outside the US.

Scenario B

A lot many US citizens who’ve been naturalized or have deep family connections outside the US, send money monthly abroad. Except this time, they don’t use any money transfer companies (perhaps they don’t trust them, etc.), but they mail in a US check. An actual physical US check is mailed to Mexico or Jordan or Israel, etc.

The family member then deposits this check at their bank and waits for a week or two before their bank clears the US check and credits their account.

In both the scenarios described above, the following holds true:

• The payment instrument is a US Check
• It is drawn on a licensed US Bank
• The check has all the information as to who issued it (its clearly marked on the check), so we very clearly know the Sending party.
• The check can only be cleared by a licensed US Bank (via the Federal Reserve) using the Check21 system.
• The funds are flowing from the US to a specific country (i.e. the flow of funds is that the funds are existing the US).
• The Bank &/or the Money Exchange company outside the US where this Check was presented has some sort of an association with a US MSB (companies like National Check & Currency) &/or US Bank for clearing and settlement of these funds.

The Problem: Check21 Processing

Because of all the de-risking that is going on, with respect to Operation Choke Point, banks and financial institutions in the US are now refusing to do business with money service businesses (MSBs).

You can read more about this in these 3-series article that I wrote:

• The Sandstorm that is blanketing the Money Services Business
• Can’t find MSB Friendly Banks?
• Banking De-Risking: The Domino Effect Is Now In Full Force.

Because of this de-risking, 1,000s of locations outside the US who specialize in clearing such payment instruments, suddenly find themselves out of business. These checks were being processed without an issue prior to Operation Choke Point.

To mitigate risk, many players have initiated caps on the amount each person can withdraw from the money exchange company outside the US.

Because KYC is a huge issue, every person coming to present a US Check for clearing is fingerprinted, there is a high-resolution photograph taken, high-resolution scan of their government issued ID, etc. So from a KYC perspective, the beneficiary has been biometric scanned and input into the database. You cannot get a more secure form of identity authentication. Also remember, the beneficiary doesn’t immediately get there money, they have to wait 2-3 days, so all the background checks, etc. can be done in a comfortable time span.

To give you a send of semblance of the type of information collected, see below the screens from the software that the likes of National Check & Currency (and presumably others) use. There is a great detail of information being captured here, and the most important part about this is, that this is exactly the kind of visibility that the bank can also get (if they opt to do so).

Images: Courtesy National Check & Currency.

The Opportunity

Financial institutions who have access to Check21 processing, who would like to assess the risk elements, the possible income potential (current processing pipeline is in excess of US$ 1 Billion) need to pay a closer attention to what the money transfer industry was processed for years when it was suddenly asked to close down.

Banks & FIs should devote time to really understand the program and how all elements work, especially how each facet of the transaction has been assessed, reassessed and looked at from all different angles to mitigate risk.

This is not some theoretical example. 100,000s of people still prefer to send money using checks abroad. Israel, Mexico and Jordan are some of the larger markets where this happens. Because of access to banking for MSBs and ironically access to banking for American citizens abroad, the check is still a trusted mechanism of sending money, no matter how antiquated or analog the process may seem like.

In summary, some points to consider:

• The Sender is very well known.
• The Beneficiary is very well documented, ten-printed and photographed.
• Limits on the transaction. Average check is US$ 950
• Good Funds settled model, there is no credit extended here.
• Adequate reserves to cover any bad checks, remember, no money is loaned out here. If the payment instrument clears, only then payment is made.
• Safe play
• Great residual income for the bank (almost up to a US$ 1 Million – easily)
• No high-risk countries
• Clean business
• Large volume
• Sustained income and float.
• Checks are drawn on US Banks
• No immediate payments, so plenty of time to do KYC and AML, etc.
• No flight of capital risk, etc

The Detailed Process: Check21 Processing, Remote Deposit Capture

I cannot stress and thank the good folks at National Check & Currency for putting this together.

The following is a detailed overview of how Check21 Processing works for foreign Remote Deposit Capture (Content courtesy: National Check & Currency).

Using RDC (Remote Deposit Capture) technology, MSB Clients are able to deposit 24/7/365 from one or multiple locations directly to the MSB’s account at the Financial Institution. Each account is titled in the MSB’s corporate name, held under the Client’s corporate EIN and is exclusive for the MSB’s deposit activity. The intermediary MSB (like National Check & Currency) is never in possession the files as they travel for settlement.

The RDC software delivers the check data, either to the “door step” of the institution, to the institution’s “core processor”, or to the Federal Reserve Bank (FRB) on behalf of the Bank of First Deposit (BOFD / ODFI).

The path of the file is the decision of the Financial Institution and ordinarily will follow the same path as the rest of the institution’s deposits.

The scanned items are read magnetically, mathematically and optically, and a comparison of the data produces a certified electronic image of the front and back or the item along with a virtual endorsement.

The scanning process will “frank” the item on the back of the check preventing the check from being negotiated in the future. “Franking” is the act of placing (writing or printing) a message across the face of a check. In today’s check processing environment, “franking a check” usually refers to printing “ELECTRONICALLY PRESENTED” across the front of the original check when the check is scanned by equipment designed to convert the check to an electronic image for further processing. The franking is designed to indicate that the paper check is now voided and should not be deposited in physical form. The paper check is usually destroyed after thirty days. What “lives” is a “certified image” on the computer screen and which the data has been encrypted to meet the standards for transmittal and processing on the Virtual Private Network of the FRB for settlement.

After the FRB receives the file from the bank’s processor, the FRB provides immediate “Cash Letter” credit to the Financial Institution’s account held at the FRB. “Cash letter” refers to a group of checks packaged and sent by one bank to another, clearinghouse, or a Federal Reserve office. The Cash Letter is accompanied by a list detailing the amount of each check, the total amount of the check, the number of checks in the cash letter, and the instruction for the account holders (Client) information at ODFI.

The FRB will then collect the funds from the bank accounts held at the FRB for the institutions which the check deposits are drawn against. The “Making Banks”, or the institutions for which the items are drawn against, has twenty-four hours (from the time of receipt) to provide the FRB the funds or a reason code (i.e. Non Sufficient Funds) for which the item has been dishonored.

The majority of the Banks and Credit Unions in the US Financial System are electronic members of the Federal Reserve Banking System allowing almost instantaneous settlement of data. Dishonored item notification occurs usually within twenty four to forty eight hours. In some cases, an item can be dishonored for up to five years after presentation.

Within the “Cash Letter”, are instructions to the FRB, for the account of BOFD where the funds are to be credited.

The activity is provided to the “core processor” on a daily basis by the FRB, usually in the evening, reconciling the activity from the prior day and ultimately posting the information to each Client account.

The MSB (in this example: NCC) process allows a Client’s deposits to be settled overnight by the FRB and credited to the Financial Institution’s account, held at the FRB, posting as available funds the following morning by 9:00am EST. Overnight settlement of funds increases the rotation of the Client’s own working capital, reduces the need for lending lines, improves profitability and helps to mitigate risk associated dishonored items.

The Client is provided “on-line” access to view the deposit and dishonored item activity as normal. Dishonored items flow back to the point of presentment electronically allowing NCC Client’s to represent dishonored items electronically via the RDC system. The process is entirely paperless.

As the data flows through the system, NCC exports the “Maker” and “Payee” information on the check deposits to Microbilt. Concurrent with tracking and reporting suspicious activity, the system matches off against the OFAC list as well as twenty-one other global watch lists that are electronically updated to the system. There is no other RDC system which “scrubs” the data as it flows for settlement.

The RDC system also has unique filters which can detect and isolate Suspicious Activities (SAR) as well as the requirement for Cash Transaction Reporting (CTR). The system allows NCC to set the parameters that will be used to trigger reports and alerts.

Although the Federal and State requirements for reporting are clear, the NCC’s RDC software system goes one step further. For example, the system can detect if the same person or entity conducts activity on different checks at different locations which aggregate and exceed the $10,000.00 for a CTR.

The system will alert the NCC Compliance Officer when a CTR or SAR is required or recommended. The system will alert if a specific type of check or transaction requires scrutiny (i.e. Refund Anticipation Loan items, Government items,) and can be set to track transactions that require documentation specific to a Government regulatory requirement (i.e. State of Florida Workman’s Compensation Insurance).

On a daily basis, NCC staff manually reviews all of the prior days deposits to determine the daily risk in each operating account for each MSB Client. Only a portion of the “available funds”, depending on the risk associated the prior days deposits, are disbursed to the customer. A “Dynamic Reserve Balance” is maintained in each Client’s Operation Account to ensure any risk to the institution of a possibility of a “negative balance”. NCC Clients are never in a negative or overdraft position in any account held at a NCC partner Financial Institution.

The daily “Dynamic Reserve” is based on the following criteria:

1) The frequency of deposits

2) The amount of the deposits

3) Any extraordinary items within the deposits

4) The risk associated with any extraordinary items

5) Any incoming ACH debiting by third parties (i.e. Western Union, etc.) 6) The historical dishonored item rate for the customer

The RDC technology can monitor and control the amount and velocity of checks by teller drawer and by store location. The limits and filters are set up in the system at the time of underwriting to limit each check to a maximum dollar amount and to set a maximum daily dollar limit. The system also be set to monitor for dishonored items and reserves. The system is centrally managed and can be set to either reject, delete or suspend a check or batch, if the maximum check or daily maximum dollar amount be exceeded.

Each NCC Client signs a Power of Attorney (Fiduciary Agreement) allowing NCC and Presto to monitor, manage risk and to release accordingly the funds back to the Client. NCC staff monitors the daily deposit activity to manage and mitigate the risk for the institution. Each NCC and Presto Client agrees that for any reason their account drops to a negative position, or, if the Client cannot maintain sufficient capitalization to manage their MSB business, then the accounts will be terminated and the funds returned. Each Client clearly understands and signs Presto and NCC Agreements explaining that any noncompliant deposits (deposits without proper identification), or suspicious activity, can be held in abeyance until sufficient information has been received or up to five years.

Finally, there is a manual component to the NCC process, which monitors the transactions and investigates the activity which the systems may alert. Any deposits associated with an “alert” will held pending an investigation. Each Check Clearing Account is reconciled daily to insure that funds reported as deposited have in fact been received by the bank and credited to the account. Monthly bank statements are reviewed to monitor the potential for external or third party funding.

Funds are only dispatched back the client in the form of a cash delivery via a Cash Logistics company or wire transfer to the Client’s account held in the MSB’s name at a local institution (Single Party Transaction).

Cash logistics is managed through the Financial Institution’s direct relationship with the Armored Delivery Company (Brinks, Loomis, Dunbar, etc.)

If you would like to learn more, please contact me (Faisal Khan) directly.